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Demand for Tourism in Portugal: A Panel Data Approach

Sara A. Proença and Elias Soukiazis

DOCUMENTO DE TRABALHO/DISCUSSION PAPER (FEBRUARY) Nº 29

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1
 Demand for Tourism in Portugal: A Panel Data Approach

Sara A. Proença
(sproenca@esac.pt)
Escola Superior Agrária, Instituto Politécnico de Coimbra
Elias Soukiazis
(elias@fe.uc.pt)
Faculdade de Economia, Universidade de Coimbra

Abstract
The tourism activity in Portugal is responsible for about 8% of the national product and
employs 10% of the total labour force. In addition, the receipts from tourism contribute
substantially in financing the current account deficit of the balance of payments in this
country. These are convincing arguments to justify the analysis of the determinants of
the demand for tourism in Portugal and might constitute an important guide-line for the
policy making institutions.
Empirical studies on this field for Portugal have shown little attention in
modelling appropriately the demand function for tourism and identifying the main
sources of tourism flows. The majority of studies take into account the demand side
determinants of tourism, usually proxied by income and price measurements, and little
attention has been given to the supply factors which might influence substantially the
tourism performance. Factors such as infrastructures in networks and accommodation
capacity in the hosting country have been ignored in such studies. Furthermore, the
empirical analysis is mainly concentrated in time-series estimations for separate
countries being potential suppliers of tourism and panel data estimations are
exceptional.
The purpose of this study is to bring into account the above elements to which
little attention has been given in the empirical literature. First, we use a combination of
time series and cross sectional data (panel data techniques) to estimate the demand
function of tourism in Portugal by considering four main countries as the basic tourism
suppliers, Spain, Germany, France and the U.K., responsible for almost 90% of the total
tourism inflows in this country. Second, in the demand function we introduce both the
demand factors (per capita income, relative prices) and the supply factors (public
investment ratio, accommodation capacity) to explain tourism performance in Portugal.
Third, dynamic panel data techniques are used to estimate the demand function of
tourism, avoiding misspecification errors, estimation inconsistency and overall
explaining the adjustment process of tourism flows.
Our empirical analysis shows that per capita income is the most important demand
determinant and accommodation capacity the most important supply determinant
explaining thus the tourism movement in Portugal. The dynamic panel data estimation
highlights the importance of the accommodation capacity as the most important factor
in attracting more tourism to Portugal. It is also shown that the adjustment process is
slow and given the status quo it is difficult to attract more tourism flows at the above
mention countries.

Keywords: Tourism demand, supply and demand determinants, panel data estimation,
adjustment mechanism.
JEL Codes: C23, D12, L83.

2
1. Introduction
Tourism is a sector that involves a multiplicity of economic activities responding to
differentiated demands with specific characteristics at the national and international
levels. The complexity and interaction of the tourism activities justify its consideration
as a special sector that integrates a set of economic activities related mainly to travelling
and accommodation services. The combination of demand (travel decision) and supply
(accommodation provision) characteristics at the national and international levels
creates some difficulties in modelling the tourism activity as a whole. However, the
increasing importance of the tourism sector in terms of its contribution to the national
product, the employment and the balance of payments creates the need to investigate the
determinants of tourism flows within a specific country, and especially for countries
with great dependence on this sector, as Portugal.
The tourism activity in Portugal generates about 8% of the gross domestic
product, represents 10% of the total employment and contributes decisively to attenuate
the current account deficit of the balance of payments. The substantial contribution of
tourism in the Portuguese economy justifies the interest in explaining the determinants
of tourism demand and, therefore, the factors which influence the decision of tourists to
choose this country as a destination place. A better knowledge of the factors that explain
the tourist’s preferences to choose Portugal as a destination place will help the policy
makers to design more adequate strategies in order to develop farther this sector.
Although the importance of tourism in the Portuguese economy is widely
recognised, little attention has been given to explain systematically its determinants.
Empirical studies in explaining the international demand of tourism in Portugal are
limited and the majority of these studies only consider demand factors (personal income
and relative prices) as the main explanatory variables of the tourism demand. The
supply factors have been systematically ignored when the demand for tourism equation
is estimated. Factors, such as, infrastructure networks and accommodation capacity
have not been considered as potential arguments in attracting more tourism inflows. The
econometric models mainly used consider cross-section or time series data and rarely a
panel data approach.
The purpose of this study is to provide an empirical analysis that contemplates the
weaknesses that have been observed with regard the demand function of tourism in
Portugal. More specifically, we introduce into the demand function supply factors as
well and we adopt a panel data estimation approach which allows for specific country

3
effects. A dynamic estimation approach is also used to capture the long term tendencies
of tourism movements.
The remaining of the paper is organized as follows. Section 2 provides a review of
the literature on the demand of tourism explaining the theoretical and empirical aspects.
Section 3 explains the specification of the demand function of tourism to estimate and
analyses the data. Section 4 presents the results from the panel estimations of the
demand function of tourism and discusses policy implication issues. Section 5 estimates
the dynamic demand function of tourism and explains the adjustment process of the
tourism inflows. The final section concludes.

2. The Demand Function of Tourism. A Literature Review

2.1. How to Define Tourism Demand
According to the literature, the underlying theory that explains the tourist flows between
the origin and the destination country is based on the demand function. The product
resulting from the demand of tourism is an aggregate amount of the individuals desire to
travel within a specific time of period. From the receiving country point of view,
tourism demand represents the set of goods and services that the visitors - residents and
non residents- acquire during a specific period of time of their permanence.
Song and Witt (2000) define tourism demand as the amount of a set of tourist
products that the consumers are willing to acquire during a specific period of time and
under certain conditions which are controlled by the explanatory factors used in the
demand equation. In these lines, Stucka (2002) reveals that the majority of empirical
studies try to model the flows of tourism between the receiving and the supplying
countries by specifying a demand function of the type Q = f (Y , P ) , where Q stands for
tourist consumption in the receiving country, Y is income per capita of the supplying
country as a measure of its purchasing power capacity and P is a relative price index to
measure price levels between the origin and the destination countries. Some other
studies also include a price-substitution effect to compare price levels between different
destination places.
The literature review on the econometric modelling of tourism demand shows
that there is not any standard measure of tourism flows universally acceptable. In fact,
the majority of the empirical studies in this area define international tourism demand by
using one of the following measures: the number of foreign visitors crossing the
borders; the number of nights spent by visitors from abroad; the receipts originated from

4
the visitors spending; or the stay-length of tourists visiting a country. None of these
measures is fully satisfactory in encompassing all the aspects which characterize the
demand for tourism in a specific location.
González and Moral (1995), in a study about the international tourism demand in
Spain, refer that one of the main problems in analysing the potentialities of the tourist
sector is to find a precise indicator to measure the external demand. Bearing in mind
that the demand for tourism is a variable not directly observable it is necessary to find a
suitable proxy to represent it. The authors use tourists spending as the dependent
variable, defined as the product of three factors: the number of tourists, the length of
their stay and the daily average spending. This is a more complete definition than using
the number of entrances to express tourism demand. The latter does not take into
account the stay - duration and spending behaviour. Cunha (2001) also argues that the
number of entrances is not a good approximation to express tourism demand since it
ignores one of the most important aspects in this sector: the demand of goods and
services that tourists require during their permanence.
Mello and Sinclair (2002), alternatively, use the share of tourism spending of the
origin country to other destination countries to study tourism demand in the U.K. The
authors argue that this variable captures the consumption behaviour of the tourists and
explains the spending component of this economic activity. It is possible to observe an
increase in the tourism inflow accompanied by a reduction in spending explained by
higher domestic inflation and shorter length of stay. For this reason the expenditure
approach is preferable to the inflows approach to study the demand for tourism
behaviour from the point of view of the hosting country.
Rodriguez and Ibanez (2001) use the number of visitors lodged in the destination
country as the dependent variable to study the demand for tourism in a panel data
approach. The choice of this variable to express tourism demand (in comparison with
the number of tourist entrances) has the advantage to consider the length of the stay and
to exclude tourists that are hosted to family or friends houses.
According to the literature review, the most appropriate variable to be used as
the dependent variable in the demand for tourism equation is tourism receipts from the
point of view of the receiving country or tourism spending from the point of view of the
supplying country (Tse, 1999; Lathiras and Siriopoulos, 1998). However, according to
Crouch and Shaw (1992), almost 70% of the studies that estimated tourism demand
functions have used the number of visitors (entrances) as the dependent variable (Qui

5
and Zhand, 1995; Morris, Wilson and Bakalis, 1995; Kulendran, 1996; Akis, 1998). The
main reason for this choice has been the unavailability of data on tourism spending.

2.2. Factors that Influence the Demand for Tourism

According to Crouch (1994a) there is a huge number of potential factors explaining
tourism demand and the specification of the demand function varies according to the
countries or regions used, the time period of the study, the type of the data (time series
or panel data) and the nature of tourism (holidays, business trips, visits to family or
friends, etc.). The choice of the explanatory variables to be included in the models is
sensitive to problems, such as, the degree of freedom loss, data reliability, collinearity
problems, omitted variable bias or endogeneity inconsistency.
Cunha (2001) identifies a set of potential determinants that can influence the
decision to travel classified into the following categories: socioeconomic factors, such
as, income level, relative prices between the origin and the destination places,
demography, urbanization and length of the leisure time; technical factors related to
easier communications and transport facilities; psychological and cultural factors
reflecting personal preferences and the style of life of the potential travellers; and
random factors related to unexpected events, like political instability, weather
conditions, natural disasters, epidemic diseases, etc.

- The Income Factor

Income (per head) is pointed out as the most important factor to influence the decision
of people to travel. It has been shown in the empirical literature that the demand for
tourism and the length of staying are directly related to the level of income (level of
personal wealth) of the potential travellers and inversely related to the domestic cost of
living. Therefore, the purchasing power position of the potential travellers is the
dominant factor in explaining tourist flows and the causality is expected to be strong
(Crouch, 1994b).
Some different variables have been used to proxy the level of wealth of the
sending country: the Gross National Product (Garín-Munoz and Amaral, 2000; Qui and
Zhang, 1995) or the Gross Domestic Product (Kulendran and Wilson, 2000; Lathiras
and Siriopoulos, 1998) in real or nominal terms but, above all, in per capita terms. Some
other studies use the Industrial Production Index (González and Moral, 1995) and the
families disposable income as measures of economic wealth. Most studies use the real

6
per capita income as the most appropriate indicator to measure peoples living standards
of the sending country.
According to Witt and Witt (1992) tourism is a luxury good with an expected
income elasticity of demand higher than one and this is what normally occurred in most
studies. On the other hand, Crouch (1995), in an attempt to review the empirical
findings on this subject concludes that income elasticities of the demand for tourism are
specific to each country and no generalization can be made about its value.

- The Price Factor

The inclusion of the price variable in the tourism demand function results from some
theoretical considerations. Tourism is a consumption good and has its own price
differentiated along different competing places of destination. Subject to his income
constraint the household of a specific country has to decide first to consume tourist
products or other type of consumption goods, specially durables. After his decision
made in favour of travelling he chooses the place to visit taking into account (among
other factors) the overall cost of his journey, trying to maximize his utility. However,
tourist demand does not only depend on its own price but also on the price of other
alternative goods and services as well as the general price level of the domestic market.
Here we have to distinguish two different situations: from the point of view of the
sending country, the increase in domestic price level reduces the purchasing power of
the potential travellers and, therefore, their demand for tourism; on the other hand, an
increase in the price level of the destination country discourages tourists to move to this
place or reallocate their demand to other cheaper competing places. In this context two
types of prices have to be considered in the demand function of tourism: the first one is
relative price between the receiving and the sending country; the second is relative price
between different competing destination places which originates the substitution price
effect1.
The relative price variable which is normally used in the demand for tourism
function is the ratio of the consumer price indexes between the receiving and the
sending countries adjusted by the bilateral exchange rate (Kulendran and Wilson, 2000;
Lathiras and Siriopoulos, 1998). In addition, some authors (Turner, Reisinger and Witt,

1
The substitution effect can be twofold: households can choose to travel inside or outside the country
they live or to choose between alternative places of destinations.

7
1998; Lathiras and Siriopoulos, 1998) introduce the same ratio between different
competing destinations to count for the price substitution effect.

- Other Factors
In some studies, total population of the sending country is used as an explanatory
variable in the demand for tourism function to count for the market size. The rationale
behind this variable is that large countries constitute a potential market for supplying
tourists and, therefore, more economies to scale can be explored.
A trend variable is also used to capture specific households behaviour, such as,
inertia, consumers preferences and habits in this sector. The same variable can also
capture cyclical effects, demographic changes in the sending country or supply
improvements in the receiving country.
The lagged dependent variable in the tourism demand function is normally
included for two reasons: first, to introduce dynamics into the demand function and
second, to capture persistence effects of the tourists behaviour. In general, tourists are
adverse to risk, preferring to spend holidays in places that are already familiar to them
or they had heard something positive about the places they plan to visit (Sinclair and
Stabler, 1997).
Witt and Witt (1995) give another possible explanation for the inclusion of an
autoregressive term in the demand function of tourism: a certain rigidity from the
supply side behaviour. Supply factors related to accommodation capacity, transportation
facilities, human capital qualifications and generally the provision of efficient services
are long term issues involving structural changes and better reallocation of resources in
the sector. Long term or medium term contracts of the operating agencies can be
another source of rigidities as Carraro and Manente (1994) point out.

2.3. Specification and Estimation Issues

The empirical literature suggests that the most commonly specifications used for
estimating the demand function of tourism are linear and log linear functions. Witt and
Witt (1995) in a review article conclude that 75% of the analyzed models used a double-
log functional form, 18% a linear specification and the remaining are probit-logit
models or semi-log specifications. The preference given to the double log specification
is due to more satisfactory estimation results obtained and easy interpretation of the
estimated coefficients through the demand elasticities (Kulendran, 1996; Morley, 1994).

8
 There is a wide variety of model estimation techniques applied to the demand
function of tourism. Using time series data the problem of no stationary data was
recognized, cointegration analysis and ECM estimation techniques were used to ensure
long term properties and non spurious causality between the relevant variables. The
estimated techniques range from ARIMA and Holt-Winters univariate Modelling (Kim,
1999) to 2SLS and 3SLS (Tse, 1999) and ECM estimation models (Kulendran and
Wilson, 2000; Lathiras and Siriopoulos, 1998). On the other hand, panel data
estimations are relatively rare in the empirical literature, especially involving dynamics.
We want to apply this recent technique to the Portuguese case were empirical studies
have not explored yet this alternative methodology.

3. Sample and Model Specification

The purpose of this paper is to study the international demand for tourism in Portugal as
a destination place for four main tourism sending countries, Spain, Germany, France
and the U.K. which count for about 90% of the total tourist inflows in Portugal. A panel
data approach is used to estimate the demand function of tourism in Portugal with
respect to its main clients for a period of 25 years (1977-2001). Annual data is
preferable in order to avoid seasonality problems which are dominant in this sector.
The empirical analysis follows the approach proposed by Carraro and Manente
(1994) where no distinction is made between different travelling motivations. Holidays
motivation is assumed to be the principal scope for travelling.
With respect to the theoretical model we assume that the tourism inflows that
Portugal receives represent “export receipts” for this country and analogically “import
expenses” for the sending country. Accordingly, export receipts (tourism inflows) will
depend positively on the purchasing power of the sending (importing) country and
negatively on the relative price (expressed in a common currency) between the
receiving (exporting) and the sending (importing) countries. In fact, the higher the
purchasing power of the sending country the higher the demand for tourism of its
citizens; and the higher the price level of the receiving country (relatively to the sending
country) the lower the demand for tourism for the receiving country as a destination
place. Relative prices have to be expressed in local currency of the receiving country.
People that are travelling abroad they concern about the amount of goods and services
they can acquire with their own currency in terms of local prices.

9
 Accordingly, the estimated demand function for tourism in Portugal involves the
following variables:

-The Dependent Variable

We use an expenditure approach to define the demand for tourism in Portugal. We
define tourism demand as the share of the expenditures of each sending country to the
total expenditures on tourism in the receiving country (Portugal):
Tourism Spendings of the Sending Country
wi ,t = (1)
Total Tourism Spendings in the Destinatio n Country
with i = 1,..,4 (the four main sending countries, Spain, Germany, France and the U.K.)
and t = 1977,….,2001. The source of the data is INE (National Institute of Statistics),
Tourism Statistics, several years.

- Explanatory Variables

1) Demand Factors
As we explained in the theoretical section, the most important factor influencing the
decision of households to travel abroad is their real personal income. As a measure of
the households wealth we use real per capita income of the sending country defined by
the following ratio:
GDPi ,t
Yi ,t = (2)
CPI i ,t ⋅ POPi ,t

where, GDP, POP and CPI are Gross Domestic Product, Total Population and
Consumer Price Index of the sending country, respectively. The source of the data is
OECD (2003), National Accounts.
A second important determinant of the demand for tourism is relative price
between the receiving and the sending countries. Relative price is given by the ratio of
the price index level of the receiving country (Portugal) and the sending country
adjusted by the bilateral exchange rate:
CPI P ,t
Pi ,t = (3)
CPI i ,t ⋅ EX i ,t

where, CPIP and CPIi are the Consumer Price Indexes in Portugal and the sending
country, respectively; and EXi is the real effective exchange rate of the sending country

10
with respect to Portugal. The source of the Portuguese data is INE and OECD for the
other variables.

2) Supply Factors
Supply conditions from the point of view of the hosting country are important factors in
attracting more tourism inflows. Having into consideration the availability of the data,
we introduce two main supply measures.
The first is accommodation capacity (A) measured by the number of beds
available each year to host the tourists who visit Portugal. The data are collected from
INE, Tourism Statistics, several years.
The second is a more general supply measure related to infrastructures (airports,
roads, railways, hospitals, telecommunications, among others) which we believe may
have welfare effects on the daily live of the tourists that visit Portugal. The ratio of
public investment to GDP (IP) is used as a proxy to capture the welfare effects
emanated from public infrastructure networks. The data for the public investment ratio
in Portugal is collected from the OECD (2003), National Accounts.
Finally, a dummy variable (D86) is used to capture the effects of the Portuguese
integration in the EU. The dummy variable takes the value of one in the years followed
the accession to the EEC (since 1986) and zero in the years before the accession. The
idea is to cheque if the border openness with the accession of Portugal in the EEC
provoked a higher inflow of tourists into the country.
Having defined the variables to include in the model we are now able to present
the full specification of the demand function of tourism in Portugal in a log linear form:
ln wi ,t = α i + β1 ln Yi ,t + β 2 ln Pi ,t + β 3 ln At + β 4 ln IPt + β 5 D86 t + u i ,t (4)

where, wi ,t is the tourism spending ratio in the host country;

Yi ,t is real per capita income of the sending country;

Pi ,t is relative price between the host and sending countries;

At is accommodation capacity in the host country;

IPt is public investment ratio in the host country;

D86 t is dummy variable to capture the integration effects;

u it is the stochastic error.

11
The data are organized in a panel form with i = 4 and t = 25 giving a total of 200
observations.

4. Estimation of the Demand Function of Tourism in Portugal

Panel data estimation techniques are used to estimate the demand function of tourism in
Portugal. The conjunction of time series and cross sectional data allows for higher
degrees of freedom in the estimation process, has the advantage to include specific
country effects, gives more data information, reduces the multicolinearity effects and
allows for dynamic specification.
Equation (4) is estimated by using the usual panel data estimation methods2 and the
results are reported in Table 1. Column (1) presents the OLS estimation results obtained
by pooling the data and column (2) reports the results from the Fixed Effects estimation
by using individual dummies for each of the sending country. With this way, differences
in structures between the sending countries are captured in the constant term. Column
(3) gives the results from the Random Effects estimation by using the GLS method. In
this case, differences in structures in the sending countries are assumed to be stochastic
and, therefore, they are introduced in the error term. In all methods of estimations the
presence of first order serial autocorrelation was detected, for this reason the maximum
likelihood method of estimation was used to remove serial autocorrelation and to obtain
efficient estimators.
The results obtained from the three alternative methods of estimation do not
reveal significant differences. The degree of explanation of the explanatory variables is
very satisfactory ( R 2 = 0.95) and the DW statistic indicates absence of serial
autocorrelation. In all methods of estimation the per capita income variable (from the
demand side) and accommodation capacity (from the supply side) are the only
explanatory variables with statistical significance. The income elasticity of the demand
for tourism is higher than one, confirming other studies findings that tourism is a luxury
good. The relative price variable has the expected negative sign in the Fixed and
Random Effects estimations but without statistical significance in all cases. This can be
taken as evidence that the relative cost of living between the host and the sending
countries is not a determinant factor in the decision of tourists to choose Portugal as the
destination place. This is an expected result since the four most important clients of

2
The estimations have been made by using the econometric program RATS.

12
 Table 1. Estimation of the Demand Function of Tourism in Portugal, 1977-2001
(1) (2) (3)
Pooled Fixed Effects Random Effects
Explanatory Variables (OLS) (LSDV) (GLS)

Constant -31.783 -33.714

(-5.715)* (-5.584)*
D1 -33.723
(-5.583)*
D2 -33.542
(-5.419)*
D3 -34.128
(-5.464)*
D4 -33.714
(-5.411)*
lnY 1.307 1.553 1.536
(2.134)* (1.998)* (2.053)*
lnP 0.004 -0.018 -0.010
(0.028) (-0.104) (-0.060)
lnA 1.379 1.347 1.340
(3.286)* (2.999)* (3.040)*
lnIP -0.069 -0.084 -0.081
(-0.373) (-0.449) (-0.439)
D86 0.039 0.046 0.045
(0.442) (0.515) (0.513)
ρ 0.903 0.854 0.858
(20.326)* (15.069)* (15.424)*

R2 0.951 0.951 0.947

DW 1.845 1.806 1.832
Notes:
OLS is Ordinary Least Squares estimation with pooled data; LSDV is Least Squares Dummy Variable
estimation with fixed effects; GLS is Generalized Least Squares estimation with random effects. The
values in parentheses are t-ratios. ρ is the autoregressive parameter.
(*) Indicates that the estimated coefficient is statistically significant at the 5% significance level.

Portugal have higher standards of living, so what matters more in their decision to travel
is their personal income and not the relative cost of living.

13
 Public investment ratio in the hosting country has not any significance in the
demand for tourism in Portugal and carries a wrong negative sign. This shows that
tourists care more about their personal accommodation facilities than the welfare gains
derived from public services. On the other hand, the dummy variable introduced to
capture the consequences of border openness after the accession of Portugal in the EEC
shows also no statistical significance but carries the expected positive sign. This is
evidence that the four main clients (Spain, Germany, France and the U.K.) are
traditionally visiting Portugal for holidays and that the integration of Portugal to the EU
did not change their attitude.
Finally, the statistical significance of the individual dummies and the almost equal
value of their coefficients show that differences between the four sending countries are
significant but influence in a similar way the demand for tourism in Portugal. Therefore,
a common constant term can be accepted in the estimated demand equation.

5. Dynamic Estimation of the Demand Function of Tourism in Portugal

The detection of error autocorrelation when estimating equation (4) can be interpreted
(according to Hendry’s methodology) as evidence of dynamic misspecification. In order
to insert dynamics into the demand function of tourism in Portugal, we introduce a
lagged dependent variable as an explanatory factor to capture persistence effects of the
tourists behaviour. The introduction of a lagged dependent variable also allows to
explain the adjustment process of the actual variation in the demand for tourism to its
desired level, trough the well known partial adjustment principle3. The dynamic
specification of the demand function for tourism with an autoregressive term takes the
following form:
ln wi ,t = α i + β 1 ln Yi ,t + β 2 ln Pi ,t + β 3 ln At + β 4 ln IPt + β 5 D86 t + β 6 ln wi ,t −1 + u i ,t
(5)
u i , t = ε i + υ i ,t

3
The partial adjustment principle admits the following hypothesis: (lwt − lwt −1 ) = δ (lwt* − lwt −1 )
which states that the actual variation of the dependent variable (lwt − lwt −1 ) is a fraction of the desired
variation (lw *
t )
− lwt −1 with lwt* the desired level (not observable) and 0 < δ < 1 the partial adjustment
coefficient, revealing the speed of adjustment: δ → 0 implies lwt → lwt −1 a slow speed of adjustment
(or stagnation) and δ → 1 implies lwt → lw* t a high speed of adjustment or instantaneous adjustment
within the same period.

14
where, the error term, ui ,t , is decomposed into two elements: an individual-specific

effect, ε i and a random effect, υi,t .

However, with this new dynamic specification (5) we face a statistical problem4:
the correlation between the lagged dependent variable and the error term ε i ,

Cov ( ε i , ln wi ,t −1 ) ≠ 0. Because of this regressor-error correlation the fixed effect (OLS)

and random effect (GLS) estimations would not be appropriate since the obtained
estimates would be biased and inconsistent, specially in small samples estimations. One
way to solve this problem is to use instrumental variables (IV) estimation techniques.
Then the problem is to find suitable instruments which are highly correlated with the
endogenous regressor but uncorrelated with the individual-specific error term.
Doornik, Arellano and Bond (2002) suggested an alternative method to estimate
dynamic panel data models based on the Generalised Method of Moment estimation
(GMM) which is a generalisation of the (IV) method of estimation. The idea is to
estimate equation (5) by first-differencing all variables (to remove the individual effect)
and then use as instruments all the lagged variables used in the model. Doornik et al.,
(2002) developed a Dynamic Panel Data (DPD) estimation approach in Ox5 to estimate
dynamic panel data models by using the GMM method.
The dynamic specification of the demand function of tourism in Portugal,
equation (5), has been estimated by the GMM method by using orthogonal deviations in
the variables6, as has been suggested by Arellano and Bover (1995). The instrumental
variables used in the estimation were all the predetermined variables, two lag periods of
the variables A and IP , the individual country dummies and the dummy D86. The
estimated results obtained are the following:

4
For more technical details see Greene (2000), chapter 14.
5
The programming procedures to estimate dynamic panel models are available in www.nuff.ox.ac.uk/
Users/Doornik/.
6
The orthogonal transformation of the variables consists in defining the difference of each value in
relation to the average of future values (at each moment) in a way to remove the individual effect without
compromising the orthogonally of the transformed terms of the disturbances, i.e.,
1
⎛ xi (t +1) + ... + xiT ⎞⎛ T − t ⎞ 2
x = ⎜⎜ xit −
*
⎟⎟⎜ ⎟ , t = 1,..., T − 1.
T −t ⎠⎝ T − t + 1 ⎠
it
⎝
7
The Sargan test allows to test the validity of the instruments used in the estimation (accepting the null
hypothesis means the use of valid instruments).

15
ln wi ,t = α i + 0.091 ln Yi ,t − 0.121 ln Pi ,t + 0.920 ln At − 0.425 ln IPt − 0.003 D86 t + 0.780 ln wi ,t −1
t − Stat. (0.103) (−0.530) (2.06) (−1.45) (−0.129) (11.0)

S tan dard Error = 0.004, RSS = 0.341, T ⋅ N = 88, S arg an Test 7 = 50.03 [1.000]

In this dynamic estimation the most significant variable is the lagged dependent
variable, suggesting strong adjustment dynamics in the behaviour of tourists coming to
Portugal. The short run income elasticity of demand for tourism looses its significance
but the accommodation capacity preserves its statistical significance. Therefore, the
dynamic estimation of the demand function of tourism in Portugal suggests that
accommodation facilities is the most important supply factor influencing the decision of
tourists to choose Portugal as the destination place.
The value of the adjustment coefficient8 ( δ = 22% ) gives evidence of a rather low
adjustment process between the actual variation of the demand for tourism and the
desired long-run level. This means that the number of tourists visiting Portugal each
year does not differ substantially from the previous years giving evidence of some kind
of inertia or rigidity in the tourism inflows. This is an expected result since tourism
demand in Portugal is concentrated mainly in four European countries (Spain, Germany,
France and the U.K.). The attraction of more tourists from these countries is a hard task
without improving the quality of the accommodation capacity. Portugal has to develop
new policies to reduce its relative dependence from these four European countries and
to explore new markets characterized by higher standards of living.

5. Concluding Remarks
The basis aim of this study was to estimate the demand function of tourism in Portugal
with respect to four main tourism suppliers (Spain, Germany, France and the U.K.) that
count for 90% of the total tourism inflows in this country. A panel data estimation
approach was used to identify the main determinants of the tourism demand in Portugal
over the period 1977-2001.
The demand for tourism equation was specified in a way to include both demand
and supply factors as the potential determinants in explaining tourism inflows in

8
From the partial adjustment mechanism (lwi,t-lwi,t-1)=δ(lw*i,t – lwi,t-1) we get lwi,t = δlw*i,t + (1-δ)lwi,t-1
and substituting the long-run equilibrium relation lw*i,t = b0 + b1lyi,t + b2lPi,t + b3lAt + b4lIPt + b5D86 we
derive the short-run model lwi,t = δb0 + δb1lyi,t + δb2lPi,t + δb3lAt + δb4lIPt + δb5D86 + (1-δ)lwi,t-1. The
coefficient of adjustment δ is taken from the estimated coefficient of the lagged dependent variable lwi,t-1.

16
Portugal. The panel data estimation approach by using a static specification provides
evidence that per capita income is the most significant explanatory factor from the
demand determinants and accommodation capacity the most significant factor from the
supply determinants. The income elasticity of the demand for tourism higher than one
confirms the usual finding that tourism is a luxury good. The relative cost of living
between the receiving and the sending country and public investment ratio in the
hosting country do not influence significantly the decision of tourists to choose Portugal
as a place of holidays destination. On the other hand, the border openness due to
accession of Portugal in the EEC does not seem to constitute a favourable factor in
inducing more tourism inflows into the country.
The dynamic panel data estimation of the demand of tourism function highlights
the importance of the accommodation capacity as the main determinant in explaining
tourism inflows in Portugal. The adjustment process between the actual and the desired
variation in the demand for tourism is shown to be slow reflecting some kind of inertia
or rigidity in the tourism movement in Portugal. As a policy recommendation, Portugal
has to reinforce the accommodation capacity by providing more qualified services in
this sector. In addition, Portugal has to explore alternative markets (countries or
regions) characterized by higher standards of living and higher demand for tourism in
the international market.

17
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19
List of the Discussion Papers published by CEUNEUROP

Year 2000

Alfredo Marques e Elias Soukiazis (2000). “Per capita income convergence across
countries and across regions in the European Union. Some new evidence”. Discussion
Paper Nº1, January.

Elias Soukiazis (2000). “What have we learnt about convergence in Europe? Some
theoretical and empirical considerations”. Discussion Paper Nº2, March.

Elias Soukiazis (2000). “ Are living standards converging in the EU? Empirical
evidence from time series analysis”. Discussion Paper Nº3, March.

Elias Soukiazis (2000). “Productivity convergence in the EU. Evidence from cross-
section and time-series analyses”. Discussion Paper Nº4, March.

Rogério Leitão (2000). “ A jurisdicionalização da política de defesa do sector têxtil da

economia portuguesa no seio da Comunidade Europeia: ambiguidades e
contradições”. Discussion Paper Nº5, July.

Pedro Cerqueira (2000). “ Assimetria de choques entre Portugal e a União

Europeia”. Discussion Paper Nº6, December.

Year 2001

Helena Marques (2001). “A Nova Geografia Económica na Perspectiva de Krugman:

Uma Aplicação às Regiões Europeias”. Discussion Paper Nº7, January.

Isabel Marques (2001). “Fundamentos Teóricos da Política Industrial Europeia”.

Discussion Paper Nº8, March.

Sara Rute Sousa (2001). “O Alargamento da União Europeia aos Países da Europa
Central e Oriental: Um Desafio para a Política Regional Comunitária”. Discussion
Paper Nº9, May.

Year 2002

Elias Soukiazis e Vitor Martinho (2002). “Polarização versus Aglomeração:

Fenómenos iguais, Mecanismos diferentes”. Discussion Paper Nº10, February.

Alfredo Marques (2002). “Crescimento, Produtividade e Competitividade. Problemas

de desempenho da economia Portuguesa” . Discussion Paper Nº 11, April.

Elias Soukiazis (2002). “Some perspectives on the new enlargement and the
convergence process in Europe”. Discussion Paper Nº 12, September.

20
Vitor Martinho (2002). “ O Processo de Aglomeração nas Regiões Portuguesas”.
Discussion Paper, Nº 13, November.

Year 2003

Elias Soukiazis (2003). “Regional convergence in Portugal”. Discussion Paper, Nº 14,

May.

Elias Soukiazis and Vítor Castro (2003). “The Impact of the Maastricht Criteria and
the Stability Pact on Growth and Unemployment in Europe” Discussion Paper, Nº 15,
July.

Stuart Holland (2003a). “Financial Instruments and European Recovery – Current

Realities and Implications for the New European Constitution”. Discussion Paper, Nº
16, July.

Stuart Holland (2003b). “How to Decide on Europe - The Proposal for an Enabling
Majority Voting Procedure in the New European Constitution”. Discussion Paper, Nº
17, July.

Elias R. Silva (2003). “Análise Estrutural da Indústria Transformadora de Metais não

Ferrosos Portuguesa”, Discussion Paper, Nº 18, September.

Catarina Cardoso and Elias Soukiazis (2003). “What can Portugal learn from
Ireland? An empirical approach searching for the sources of growth”, Discussion
Paper, Nº 19, October.

Luis Peres Lopes (2003). “Border Effect and Effective Transport Cost”. Discussion
Paper, Nº 20, November.

Alfredo Marques (2003). “A política industrial face às regras de concorrência na

União Europeia: A questão da promoção de sectores específicos” Discussion Paper, Nº
21, December.

Year 2004

Pedro André Cerqueira (2004). “How Pervasive is the World Business Cycle?”
Discussion Paper, Nº 22, April.

Helena Marques and Hugh Metcalf (2004). “Immigration of skilled workers from the
new EU members: Who stands to lose?” Discussion Paper, Nº 23, April.

Elias Soukiazis and Vítor Castro (2004). “How the Maastricht rules affected the
convergence process in the European Union. A panel data analysis”. Discussion Paper,
Nº 24, May.

21
Elias Soukiazis and Micaela Antunes (2004). “The evolution of real disparities in
Portugal among the Nuts III regions. An empirical analysis based on the convergence
approach”. Discussion Paper, Nº 25, June.

Catarina Cardoso and Elias Soukiazis (2004). “What can Portugal learn from
Ireland and to a less extent from Greece? A comparative analysis searching for the
sources of growth”. Discussion Paper, Nº 26, July.

Sara Riscado (2004), “Fusões e Aquisições na perspectiva internacional:

consequências económicas e implicações para as regras de concorrência”. Documento
de trabalho, Nº 27, Outubro.

Year 2005

Micaela Antunes and Elias Soukiazis (2005). “Two speed regional convergence in
Portugal and the importance of structural funds on growth”. Discussion Paper, Nº 28,
February.

Sara Proença and Elias Soukiazis (2005). “Demand for tourism in Portugal. A panel
data approach”. Discussion Paper, Nº 29, February.

22